This article was originally published by the Baton Rouge Bar Association in November, 2016 in its monthly publication, Around the Bar. See original.

Prior to enactment of the Louisiana Business Corporation Act (“LBCA”) on January 1, 2015, minority shareholders of Louisiana corporations were afforded few remedies against a corporation for actions considered to be unfair or in bad faith against those shareholders lacking control. One of the substantive additions to the LBCA is a cause of action predicated on “shareholder oppression”, which gives unfairly treated shareholders the right to withdraw from the corporation—in exchange for the “fair value” of their shares—if the corporation’s conduct is deemed to be “oppressive” as defined by statute. As this cause of action is new and is likely to give rise to a new wave of shareholder litigation, the purpose of this article is to give practitioners some basic guidance on how oppression is defined under the LBCA and some practical ramifications of the statute.[1]

What is Oppression?

Under La. R.S. 12:1-1435(A), “[i]f a corporation engages in oppression of a shareholder, the shareholder may withdraw from the corporation and require the corporation to buy all of the shareholder’s shares at their fair value.” What, then, is “oppression”? Because the Model Business Corporation Act does not define oppression, the scope of oppressive conduct has evolved through various tests devised by state judges. As these tests are often highly fact-intensive, a wide range of conduct has been deemed oppressive. For example, courts have found that inadequate dividends,[2] wrongly terminating a shareholder’s employment,[3] and usurping corporate opportunities[4] constituted oppressive conduct.

Fortunately, the LBCA features a definition of oppression—which has been called “the most extensive definition of oppression” in the country[5]—that combines the two leading tests used by other states: the “reasonable expectations” test and the “departure from standards of fair dealing test.”[6] Under the LBCA, a corporation has engaged in oppression “if the corporation’s distribution, compensation, governance, and other practices, considered as a whole over an appropriate period of time, are plainly incompatible with a genuine effort on the part of the corporation to deal fairly and in good faith with the shareholder.”[7] Hence, the LBCA incorporates the “fair dealing” element into the definition.

Two factors are deemed “relevant” in assessing the good faith and fairness of the corporation’s practices: (1) the conduct of the shareholder alleging oppression; and (2) whether the conduct would be considered fair by a reasonable shareholder under the circumstances, considering the reasonable expectations of all shareholders in the corporation.[8] The leading case on the “reasonable expectations” test explains that oppression arises “when the majority conduct substantially defeats expectations that, objectively viewed, were both reasonable under the circumstances and were central to the [shareholder’s] decision to join the venture.”[9] The LBCA correctly omits the requirement that the shareholder prove the alleged oppression somehow defeated the shareholder’s original reasons for joining the venture. As the comments to the statute note, many shareholders acquire their shares through family inheritance or donation, meaning such shareholders likely had little to no expectations when becoming an investor in the corporation.[10] Instead, the statute directs the court to view the fairness of the conduct considering the reasonable expectations of all shareholders in that particular corporation.

Thus, the statute features an objective element—the reasonable expectations of all shareholders in the corporation—as well as the subjective element of the shareholder’s conduct. Often, the corporation’s actions, although perceived as unfair, may be the direct result of shareholder misconduct. For example, corporate conduct has been deemed justified when the shareholder converted corporate property[11] or was a substandard employee.[12] Undoubtedly, the biggest challenge facing Louisiana courts will be balancing the conduct of the shareholder against the conduct of the corporation in establishing the line of demarcation of conduct that is “fair” and conduct that is “oppressive.”

Procedural Considerations

As the procedure for filing an oppression suit is fairly straightforward, a full discussion is beyond the scope of this article. However, it should be noted that the statute contemplates a potentially bifurcated process. First, the parties must litigate the threshold issue of whether the corporation engaged in oppression.[13] Second, if the corporation’s conduct is found to be oppressive, the parties may file a second proceeding directing the court to determine the “fair value” of the withdrawing shareholder’s shares.[14] If fair value is to be determined by the court, one of the major substantive additions of the LBCA is the statutory prohibition against the use of minority or marketability discounts. While previously unsettled in Louisiana law, the LBCA explicitly directs the court to use customary and current valuation concepts “without discounting for lack of marketability or minority status.”[15]

A judgment against the corporation for oppression may be problematic for many closely-held corporations, such as those owned by combative family members, as conflict among the shareholders may result in the corporation being forced to buy out the withdrawing shareholder at a price beyond the corporation’s available cash. For example, envision a corporation owned by three shareholders in equal proportions valued as a going concern at $10 million. If one of those shareholders prevails in an oppression suit, the corporation would be forced to purchase those shares at fair value, which, given the statutory prohibition against discounts, could be valued at $3.33 million. Fortunately, the LBCA includes safeguards for judgments against cash-strapped corporations. If “full payment in cash of the fair value of the withdrawing shareholder’s shares would violate the provisions of R.S. 12:1-640 [improper distributions] or cause undue harm to the corporation or its creditors,” the court may allow the corporation to purchase the withdrawing shareholder’s shares in exchange for an unsecured promissory note.[16] The promissory note, to be issued within thirty (30) days of the judgment, must: (1) be payable to the order of the shareholder; (2) be in a principal amount equal to the fair value of the withdrawing shareholder’s shares; (3) bear simple interest on the unpaid balance of the note at a floating rate equal to the judicial rate of interest; and (4) have a term no longer than ten years.[17]

Practical Considerations

What, then, should corporate practitioners do to ameliorate the possibility of oppression lawsuits? Besides the obvious—advise the corporation not to engage in oppression—oppression suits may be unavoidable in the closely-held or family-owned context, and indeed presents a new weapon to disgruntled shareholders. First, the statute provides that the shareholders may waive the right to withdraw from the corporation on grounds of oppression by unanimous written consent.[18] Second, the statute features the caveat that “[c]onduct that is consistent with the good faith performance of an agreement among all shareholders is presumed not to be oppressive.”[19] A comprehensive shareholders agreement outlining permissible shareholder conduct could protect the corporation against allegations of oppression. Alternatively, the LBCA features a new shareholder governance device known as a “unanimous governance agreement.” A unanimous governance agreement allows the shareholders to deviate from any provision of the LBCA provided the deviation does not violate public policy.[20] Presumably, shareholders could use a unanimous governance agreement to limit certain effects of the oppression remedy, such as permitting the use of minority or marketability discounts when valuing their shares upon withdrawal. Finally, when advising clients looking to form a new business, it should be noted that the shareholder oppression remedy is limited to corporations. The use of LLCs over corporations is likely to increase given the LBCA’s emphasis on shareholder rights.

Conclusion

Louisiana has now joined the many states recognizing shareholder oppression as a cause of action, granting minority shareholders greater leverage when challenging the actions of the controlling shareholders. As this will undoubtedly increase the prevalence of shareholder lawsuits, practitioners should familiarize themselves with the oppression statute and its potential ramifications.

[1] The author is aware of oppression cases pending before Louisiana circuit courts addressing the issue of the oppression statute’s retroactive application (or lack thereof). Given that corporate oppression is meant to occur “over an appropriate period of time,” the potential non-retroactivity of the statute is worth watching, as it may preclude otherwise oppressed shareholders from seeking withdrawal if some or all of the alleged oppression occurred prior to January 1, 2015.

Disclaimer: The information provided herein (1) is for general information only; (2) does not create an attorney-client relationship between the author or the author’s firm and the reader; (3) does not constitute the provision of legal advice, tax advice, or professional consulting of any kind; and (4) does not substitute for consultation with professional legal, tax or other competent advisors. Before making any decision or taking any action in connection with the matters discussed herein, you should consult with a professional legal, tax and/or other advisor who should be provided with all pertinent facts relevant to your particular situation. The information provided herein is provided “as is,” with no assurance or guarantee of completeness, accuracy, or timeliness of the information.